Buying a Business – Identifying and Managing Risk

When buying a business, a detailed due diligence process serves as a critical investigative tool, allowing buyers to make informed decisions and manage potential risks effectively. Whether you are a first-time or seasoned buyer, understanding and navigating the risks involved is essential. This article examines the importance of due diligence and highlights three common legal challenges that often arise in the process.

Choosing a Business Structure

Before beginning negotiations, buyers should consider the structure of the proposed acquisition, which typically falls into one of two categories:

• Share Purchase: Involves acquiring shares in the entity that owns and operates the business. Here, the buyer inherits both the assets and liabilities of the business.
• Asset Purchase: Involves the transfer of specific business assets from the seller to the buyer. This may also include the assumption of certain agreed-upon liabilities.

Selecting the appropriate structure early in the transaction is crucial, as it influences the nature of the due diligence process, the sale terms, and the necessary steps for transferring ownership.

The Due Diligence Process

Due diligence enables the buyer to identify and mitigate actual or potential risks by thoroughly reviewing and analyzing the target entity and its assets. This process is both forward-looking, to assess the strategic and financial soundness of the investment, and backward-looking, to ensure that the target assets or shares have a compliant and traceable history.

Typically, a buyer's due diligence covers three main areas:

• Commercial and Operational Due Diligence: This encompasses evaluating management, infrastructure, systems, risk management processes, and key relationships, such as those with customers and suppliers.
• Financial Due Diligence: Confirms the target's historical financial performance and future growth potential.
• Legal Due Diligence: Reviews existing or potential legal issues that could impact commercial and operational considerations.

Buyers usually work with a team of advisors—including legal, accounting, tax, and business consultants—to compile a due diligence questionnaire, which is sent to the seller's advisors. The seller then provides responses and relevant documentation to support their answers.

While it’s rare to find transactions entirely free from risk, a well-structured due diligence process will uncover significant risks, allowing the buyer to address them during negotiations. Three areas that buyers frequently scrutinize are intellectual property rights, regulatory compliance, and existing contracts.

1. Intellectual Property

Intellectual property (IP) may include trademarks, patents, copyrights, trade secrets, and proprietary software. In some businesses, IP is the primary or sole asset. In these cases, due diligence should involve an IP audit to verify:

• The ownership and validity of the IP assets, both registered and unregistered,
• Existing licensing arrangements, if any, and
• Whether the IP can be transferred freely.

The results of the IP audit will guide the drafting of IP-related provisions in the transaction documents.

2. Regulatory Compliance

It is essential to determine whether any regulatory requirements might impact the acquisition and, if so, to address these requirements in the transaction documents. The due diligence process assesses both past compliance and the target’s capability to maintain compliance. If non-compliance issues arise, the buyer may require that the transaction be conditional on regulatory compliance, which might involve:

• Applications and approvals for necessary licenses and permits, and
• Compliance with employment and labour laws, including resolving any outstanding workplace issues or claims.

Non-compliance can adversely affect a business’s value, operations, and reputation. If the seller has not adequately managed regulatory compliance, buyers should evaluate the potential legal risks and reconsider the purchase price.

3. Contracts and Agreements

A business may have existing agreements with suppliers, customers, employees, landlords, or lenders. In a share sale, these agreements may contain provisions requiring consent or notification for a change in control. In an asset sale, certain contracts may require consent or notification before assets can be assigned or transferred.

In these cases, the transaction documents should include conditions requiring the seller to obtain any necessary consents or provide required notifications to the other parties involved.

Contact Us

A thorough, well-planned due diligence process will reveal the risks that must be addressed during negotiations and managed through strategic contract drafting. The Corporate & Commercial team at Carter Newell has extensive experience advising both buyers and sellers in business transactions and can help you structure and complete a successful acquisition.

Authors: Peter Motti, and Emily Cooper, Carter Newell

Peter Motti Peter has more than a decade of experience assisting clients navigate the law to achieve their corporate and commercial goals. Described by clients as accessible, responsive, sharp, and straight-talking, Peter combines his commercial nous with specialist legal expertise, both his own and that of fellow Partners, to tailor his advice and best achieve outcomes for his clients. His experience includes advising clients, both nationally and internationally, on corporate governance, mergers and acquisitions, capital raisings, employee share schemes, commercial contracts, PPSR and general commercial matters within a broad range of industry sectors including agriculture, technology, engineering and infrastructure, government, real estate, and communications.  Peter’s clients range in size from large family enterprises to ASX-listed and multinational corporations.

Emily Cooper